Clients that operate their trade through a company will sometimes need to purchase capital equipment, like plant and machinery, in order to carry on the trade.
If the company does not have the cash available to fund the purchase, a director might be willing to do so. They do this by purchasing the equipment personally, then making it available for use by the company. The client in our case is considering doing this on the basis that the capital allowances (CAs) will attract tax relief at 40%, i.e. the higher rate for income tax.
It’s certainly the case that a director might be able to claim CAs, offsetting these against the salary from the company. However, this won’t always be the case. To be eligible for CAs a company must use the equipment in their business, while directors or employees must use the equipment to carry out the duties of their job. This distinction can be a vital factor.
Example 1. John is director of Acom Ltd, whose role is admin and sales. Acom needs a new machine for the factory. If John buys it personally and Acom’s employees use it in the company’s trade, he is unlikely to be able to persuade HMRC that’s it’s required for his duties as a director meaning neither he nor Acom will get CAs.
Example 2. Sue is a director of Bcom Ltd, which is a one-person company. It too needs a new machine, which Sue buys. She’ll use it, not in her role as director, but in her job which is to produce the widgets sold by Bcom. Sue can claim CAs.
Rates of CA
Directors, employees and businesses are entitled to CAs at the same rates. For machinery, if the cost is within the annual investment allowance limit (currently £1 million until 31 December 2020) each can claim a tax deduction from their profit/income for 100% of the cost for the year of purchase. Otherwise they can claim a deduction of 18% of the cost each year on the reducing balance. The potentially big difference is that the highest rate of tax relief allowed for the deduction is 19% for companies, but up to 45% for directors and employees. This is what the director in our case is focusing on, but there are other factors to consider.
What the director has overlooked is that, so that she isn’t out of pocket, the company will need to pay her to cover the cost of the purchase, which will be taxable income, probably a dividend. The director won’t be able to reclaim VAT, whereas the company could if it made the purchase itself, assuming it is VAT registered. In fact, when all the tax consequences are considered and preparing comparative calculations, it will be more efficient to make the purchase through the company (see Follow up ).
If your client’s company can’t raise the funds to purchase machinery, but the directors can, advise them not to buy it personally and claim the tax deductions against their income. Instead, advise them to lend the money to the company so it can make the purchase. They can even charge interest on amounts lent as a means of profit extraction.